Leapfrog's Great Leap Forward

What's the right way to launch a technology product in an era when technology has lost much of its luster? First, make the technology hard to see and easy to use. Second, do everything yourself — from designing chips to running focus groups. Third, don't just sell products: Champion a platform. These are some of the principles behind the rise of LeapFrog Enterprises, whose stellar performance represents a strategic leap for the tech business.

Seven seconds. For Jim Marggraff and his colleagues at toy maker LeapFrog, seven quick ticks on a stopwatch is all the time they have to win over the world's most discerning consumers: toddlers, grade-schoolers, and tweeners. It took years of watching kids interact with prototypical toys to yield Marggraff's Seven-Second Rule, which is scrawled across a whiteboard in his office: "If the product's art and audio fail to engage the user within 7 seconds, the user will never engage."

That homely, hard-won observation was foremost in Marggraff's mind in the autumn of 1999 as he and the LeapFrog team prepared to roll out a toy that took two years of late nights to produce. Based in Emeryville, California, LeapFrog was a niche entrant in the serious business of producing playthings that make kids go bonkers. It was embarking on an audacious challenge: to take on the $25 billion toy industry, a cutthroat world ruled by heavyweights Hasbro and Mattel — a world where two-thirds of all new launches ultimately fail. LeapFrog was touting "a toy in its shape, but an educational product in its soul," as the company likes to put it. And in 1999, the year of such blockbusters as Hot Wheels and Poké mon, the educational-toy category was a dreary place to be.

LeapFrog's toy, dubbed the LeapPad, sought to bring 21st-century technology to paper. The company's claim: Using its custom-designed chip, software, and a built-in speaker, the LeapPad would make paper come alive with sound and music as young readers interacted with the device. LeapFrog called the technology "paper-based multimedia." Toy-industry veterans who had seen the prototype were less than sanguine about its chances, arguing that the cost of manufacturing the gizmo would keep it from denting the mass market. As the LeapPad's October launch date neared, even Marggraff, who shotguns all of the company's content development, conceded to some second-guessing. "Our worst nightmare was that kids would pick the thing up, play with it for a few minutes, and forget about it," he recalls. "There was a lot of paranoia and nervousness over whether we would succeed."

These days, the hyperdriven Marggraff still admits to nervousness, but the paranoia has subsided. Retailing at $49.99, the laptoplike device that makes books speak raced past the supercharged Razor scooter to become the top-selling toy in December 2000 — the first time in at least 15 years that an educational toy took the number-one ranking. As anyone in the toy business will tell you, nothing is tougher than surpassing a past success. But here again, LeapFrog defied the odds: The LeapPad swept every industry category to become the number-one selling toy in the nation for all of 2001. So far, the company has sold more than 8.6 million LeapPad systems. In a little more than three years, sales of the LeapPad are almost equal to the early success of the Palm, one of the best-selling tech gadgets in recent years.

Now LeapFrog is attempting to leverage the runaway success of the LeapPad to become a powerhouse in its own right. To that end, the 8-year-old firm has won some big-name backing. Larry Ellison and Michael Milken hold a majority stake in LeapFrog through their educational holding company, Knowledge Universe Inc. They took LeapFrog public in last July's bear market, and its stock soared 93% for the year, making it the best-performing IPO of 2002. The infusion of capital (LeapFrog raised $115 million through the IPO) and the company's continuing success on Main Street is paying off. LeapFrog recently bounded past Lego Systems to become the third-largest toy maker in the United States.

Almost inevitably, LeapFrog's success has brought with it a new set of risks. Analysts worry that the young company is overly reliant on too few retailers for most of its sales, particularly the ailing Kmart and Toys "R" Us, whose debt rating was lowered in March. Meanwhile, the industry's big guns are setting their sights on the educational category that LeapFrog rules. In August, Mattel's Fisher-Price division is expected to launch its PowerTouch Learning System, which will compete head-to-head with the LeapPad. Now LeapFrog faces its toughest challenge of all: overcoming its stakeholders' expectations. The size of that challenge was made clear in February, when the company's shares sank 16% in a single day. The reason? Despite a robust year-end earnings report that saw 2002 revenue swell by 69%, LeapFrog's guidance for 2003 implied that revenue growth would drop to 25%.

Finding a way to top last year's performance won't be easy, but LeapFrog likes its chances. For starters, the company has positioned itself to capitalize on the desire of many parents to boost their kids' reading and math skills at an early age. Some experts argue that such eagerness is ludicrous. "There's no evidence to suggest that every child needs to learn how to read by the age of four," says Catherine Snow, a professor at Harvard's Graduate School of Education. Still, the country's current passion persists for toys that aim to enlighten. While no one at LeapFrog would claim to have anticipated the trend, that old maxim holds true: Good fortune comes to a prepared mind. LeapFrog has readied itself for rapid, unpredictable market changes by operating according to a set of principles that run very much against the industry's conventions.

Consider LeapFrog's heretical views on technology. The company competes in an industry where today's hit toy is more than likely fueled by a computer chip and software. Power Rangers on handhelds, electronic Mr. Potato Heads — most of these wonders are big on the gee-whiz factor and not much else. LeapFrog has assembled a crack team of software developers and mechanical-engineering veterans, and in the LeapPad, they have developed an ultrasophisticated technology that is easy for kids to use and won't intimidate parents. Unlike the video games and other chip-driven toys that populate the industry, the LeapPad's technology is critical — but largely invisible. And that's just the way LeapFrog wants it.

"In the long run, kids could care less about technology. Look at all of the flashy gadgets that end up at the bottom of a child's toy chest," says Mike Wood, LeapFrog's president and CEO. "That's a humbling lesson for us. We need technology to deliver a spectacular experience, but the experience itself comes out of the content. Ultimately, the technology is irrelevant."

To Do It Right, Do It Yourself

Apparently, LeapFrog never got the memo that 1999 is over. The company's headquarters, which occupies a sprawling renovated warehouse in an industrial no-man's-land north of Oakland, crackles with energy. Every square foot of the hangar-sized building is honeycombed with cubicles belonging to some 800 people. (The dearth of available space has forced more than a few LeapFroggers to encamp in the hallways.) LeapFrog's rapid growth has resulted in a hiring blitz that forced the company to move to ever-larger spaces three times in the past three-and-a-half years. The company plans to expand again within the next few months.

Except for an 80-person tech team based in Los Gatos and an international network of satellite sales-and-marketing offices, all of LeapFrog's staffers work under one roof. That's because LeapFrog does everything in-house, from designing product, to mapping out educational components, to developing ASIC chips, to coding software, to producing audio, to writing and illustrating content, to running focus groups, to testing product, to strategizing the marketing plans. Nothing is farmed out to subcontractors. At issue is quality control: LeapFrog believes that it can do a better job if it does the job itself.

There's also the matter of generating a bigger ROI. By the time the chip team is designing its seventh iteration of ASICs or the content team is writing its 200th book, it will have developed an expertise that inevitably bolsters the bottom line. "There's a lot of institutional wisdom that gets passed around when all of us are working in the same space," says Wood. "By collectively yoking people's passion and energy, we raise the art of the possible."

Wearing a denim shirt and a purple tie bedecked with leaping green frogs (of course), Wood has the sparkling blue eyes and impish smile of a man who has not lost touch with his inner kid. LeapFrog's origins date back to Wood's frustrations, some 12 years ago, with trying to help his then-3-year-old son understand that letters represent sounds and that, taken together, sounds become words. At the time, Wood was a lawyer with San Francisco firm Cooley Godward, where he once represented a "talking" greeting-card company. "I was fascinated by this audio chip embedded in their cards that played these little musical messages," he recalls. "And I thought, 'What if I put chips inside a set of squeezable letters, so that when kids touched a certain letter, they would hear its phonetic sound?' "

Wood enlisted Robert Calfee, an emeritus professor at the Stanford School of Education, to help him develop a phonics program for his invention: a tray-sized keyboard with oversized, colorful letters that sound out simple words. Acting on the advice of a toy-industry veteran, Wood convened a focus group of 20 mothers to review a prototype, "because the worst thing in the world is chasing an idea without knowing whether it will work." The verdict: Most of the women loved it, but just 2 out of the 20 said that they would pay more than $50 for it. That was a problem. "I was planning on retailing it for at least $100," Wood laughs. "Great idea, except that nobody's going to buy it."

It took Wood another three years of working with Calfee and tech gurus from Sandia National Laboratories before he figured out a way to produce a $50 talking alphabet. But the big break didn't come until he demonstrated the device to a Toys "R" Us buyer, who said that he would purchase 40,000 if Wood could mass-produce it. That one single order gave Wood the validation that he needed to leave his law partners and embark on the perilous road of launching his own startup. LeapFrog was born, and its first product, the Phonics Desk, remained one of the company's best-sellers for years.

Wood's three years of working to build the Phonics Desk yielded something that has ultimately proved invaluable: the process that LeapFrog has used to develop every product it has ever marketed. "It's a five-step sequence," says Wood. "Understand the problem you want to help kids solve; ally with educational experts to figure out the best way to teach the concept; work with the best technology people to present the content in a way that's intuitive and engaging; meet with parents for a reality check; and get that buy in from retailers to ensure that you've got the demand before you commit to delivering the supply.

"If we don't get an A+ at every step of that process, we won't do the launch," Wood continues. "Not every A+ product succeeds in the marketplace, but you might as well start with the bar set as high as you can possibly get it. Because you'll never get A+ results out of a B+ product."

Money and a Mentor

Wood founded LeapFrog just as the dotcom fever was heating up. But the young Bay Area company was for the most part immune to the tech mania that swirled all around it, largely because LeapFrog's first round of funding came from Wood's family and friends. LeapFrog's original office was all of 1,000 square feet. Wood and three colleagues worked at desks that consisted of chunks of plywood plunked across sawhorses. Such frugality was to some degree self-imposed: By turning their backs on the VC money that was saturating so many high-tech startups, Wood and his team hoped to instill the discipline necessary to build a sustainable enterprise.

Then again, external forces exerted their own kind of discipline. At its core, LeapFrog is a technology company that competes in the consumer-goods market, which means that it couldn't take four years to develop product or to grow at all costs to grab market share. "We're in the business of putting products on store shelves, where either they sell or they don't sell. There's no halfway," says Wood. "You execute, and you get to do next year's plan. You fail, and next year's plan is irrelevant. At every turn, that fact forced us to focus on the bottom line."

In its first two years, LeapFrog rode the success of its Phonics Desk. Business Week crowned it one of the best-designed products of 1996. But LeapFrog was plagued by the kinds of mistakes that so often befall rookie companies. Lacking the clout to connect with a major manufacturer, Wood partnered with a minor leaguer that couldn't keep pace with demand, resulting in late shipments and a $200,000 shipping bill for catch-up deliveries. Then LeapFrog lost its account with Wal-Mart, the largest toy retailer in the United States.

"We placed the original Phonics Desk in Wal-Mart during our second year, and it had a remarkably good sell through," Wood recalls. "But then Wal-Mart decided that it didn't want to carry lots of product from just one company, and they dropped us. That showed we really didn't understand our retailers — and we certainly didn't have a relationship with the senior managers who were formulating Wal-Mart's strategy. Losing Wal-Mart was a devastating blow." (Later, LeapFrog won Wal-Mart back. And in April, the company was named Wal-Mart's Vendor of the Year.)

The Wal-Mart debacle pushed Wood to look for an outside investor. On paper, the company was doing well. By 1997, it had seven products on the market. In three years, it had grown from $3.2 million in sales to nearly $18 million. But LeapFrog lacked the capital to implement its best ideas, and it was making too many mistakes. And so Wood sold a 65% stake in LeapFrog to Knowledge Universe for $50 million.

Knowledge Universe's marquee names might belong to Ellison and Milken, but for Wood, the deal's closer was the chance to enlist a man named Thomas Kalinske, the VC fund's president. Kalinske had been president and CEO of Mattel and Sega of America, two giants of the industry. He knew the leaders of virtually every major toy retailer in the country. And his marketing instincts were honed from more than 30 years of working in the field.

Such facts weren't lost on Wood, who understood that in financing, what matters most is where the money flows from. The relationships and expertise that came with the money would help him build his enterprise. The money itself was almost secondary: Knowledge Universe's investment was a much-needed infusion of capital and — even more important — credibility. Wood's upstart operation was now in a position to take that great leap forward.

From Breakthrough Product to Breakthrough Strategy

Not long after sealing the deal with Knowledge Universe, Wood met up with Marggraff. An electrical engineer and computer scientist, Marggraff had also taken on the life of an entrepreneur. In 1995, after his company was acquired by Cisco Systems, he launched Explore Technologies, which produced an interactive globe for retailers such as the Sharper Image and Neiman Marcus. The Odyssey Globe (now marketed by LeapFrog) is equipped with a pen-sized stylus. When the stylus touches a point on the surface, a speaker chirps the name of the country. Its technology, NearTouch, is simple but ultraelegant: Inside the globe, a tiny circuit emits a radio-frequency signal, which radiates out through a layer of conductive paint on the globe's interior. Acting as a kind of antenna, the stylus picks up the signal, and software pinpoints the pointer's location on the globe.

When most technologists come up with a breakthrough innovation, their instinct is to make it even more sophisticated. Marggraff and his team were no exception. When Wood first met them, they were attempting to create a 3-D, interactive model of the human body — a spectacular engineering challenge, given the body's irregular surface. Wood was impressed with the NearTouch system, but his inclination was to dumb it down. "In a sense, I wanted to take the air out of that globe — to flatten this three-dimensional technology and make it two-dimensional," he says. "The goal was to see if they could take the globe's touch-sensitive surface and apply it to paper."

Shortly thereafter, Marggraff and his team came up with a rough Plexiglas prototype of the LeapPad, which Marggraff demonstrated at an off-site meeting for LeapFrog's leadership team. He placed a piece of paper on the pad, touched it with the globe's electronic pointer, and the pad's GPS-like system pinged the pointer's location. As Marggraff dragged the pointer over the paper's letters, software "read" the text through a speaker. The demo was a revelation to Wood and his colleagues: "That crude little prototype made static text come to life. We thought that if we built it right, it could change the way kids learn to read."

From the beginning, Marggraff had envisioned the LeapPad as a kind of computerlike platform that could accommodate an infinite number of different books, from math, geography, and vocabulary texts to Winnie the Pooh stories and Superman comics. And that was the strategic breakthrough: Marggraff's insight got LeapFrog out of the murderous cycle of having to come up with an entirely different hit toy for every holiday season. For LeapFrog, the big challenge is to keep selling LeapPads — and to keep kids coming back for more books, which retail for $14.99. So far, LeapFrog is succeeding. Last year, the company sold four books for every LeapPad, almost doubling its 2001 ratio. In fact, sales of LeapPad books surpassed the LeapPad itself, becoming the toy industry's best-selling product. Now LeapFrog is working furiously to replicate its platform model. To date, it has launched nine separate learning systems for every age category, from toddlers to teens.

LeapFrog's leadership team feels that the key to continued success is to maintain the focus and discipline that have served it so well. So far, the company has proven that the right way to launch technology-based products today is to rein in the technology. "We create products that solve problems. Everything is subordinate to the goal of engaging kids with an effective learning experience," says Marggraff. "We could add screens and flashing lights to our stuff, but we won't do anything that could get in the way of what we're trying to accomplish in this medium. If it looks and smells like technology, we haven't done a good enough job of integrating it into the product."

Bill Breen (bbreen@fastcompany.com) is a Fast Company senior editor. Learn more about LeapFrog Enterprises on the Web (www.leapfrog.com).

A version of this article appeared in the June 2003 issue of Fast Company magazine.